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Growing Profits Show Offshore Drilling Isn't Dead Yet

If the offshore drilling market is struggling, you wouldn't know it from Ensco's (NYSE:ESV) third-quarter results. Revenue was up 8.5% from a year ago to $1.26 billion, and net income from continuing operations rose 13.3% to $429.4 million, or $1.93 per share. That crushed Wall Street's expectation for $1.61 per share in earnings.

But in the drilling industry the devil is always in the details, and Ensco gave us an early peek into the potential future of offshore drilling.

Offshore drilling rigs take many shapes and sizes depending on where they're drilling for oil and gas. Image source: Seadrill.

Offshore drilling is cooling The biggest question facing offshore drillers is whether demand for rigs will match the supply that is growing every month. So far, so good.

Ensco's utilization rate slumped slightly from 90% a year ago to 88% in the third quarter, but that was still high enough to maintain strong profits. And three new rigs that began service during the quarter helped push dayrates up 5% to an average of $237,000.

We haven't yet seen a big slowdown in offshore drilling due to recent low oil prices. But a further slowdown due to falling prices could be bad for the industry, because 87 new floaters are on order or under construction and 128 new jackups are expected as well. If demand is only strong enough to soak up today's supply we could see pricing pressure as supply explodes in the next three years.

Shallow-water rigs like this one are still profitably drilling for oil, according to Ensco. Image source: Seadrill.

It's still profitable to drill for oil One highlight from Ensco's report is that shallow-water drilling is still profitable at today's commodity rates. That's great news for Ensco, as well as companies such as Hercules Offshore(NASDAQ:HERO), which has focused entirely on shallow water.

This could also help competitors such as Seadrill(NYSE:SDRL), which is also investing in new high-specification shallow-water rigs. If these new rigs can find work because it's still profitable to drill for oil and natural gas in shallow water, it could help Seadrill and Ensco remain profitable if floater demand falls off in the next few years.

Debt markets are open for offshore drillers The other significant development for Ensco -- which should also draw the attention of Seadrill investors -- is that debt markets remain open to offshore drillers. The stock market might have seen a huge sell-off over the last six months, but in the third quarter Ensco sold two $625 million unsecured debt offerings due in 2024 and 2044, with 4.5% and 5.75% coupon rates, respectively.

The 30-year bond is particularly impressive considering the uncertainty facing offshore drilling right now. It also indicates that financing new rigs in the future might be easier than the market is pricing in.

Offshore drilling is safe ... for now Uncertainty and low oil prices have absolutely crushed offshore drilling stocks in 2014, but Ensco's earnings and debt offerings demonstrate the industry is still operating profitably.

As Ensco, Seadrill, and their peers upgrade their fleets with newer rigs, I think they'll be well positioned for sustained profitability even if the market cools off. It has been demonstrated time and again that new rigs will find work before old rigs that the industry is beginning to scrap. That plays into the hands of forward-looking rig operators and is why Ensco and Seadrill are two of the top picks in the industry.